Apollo Global Management believes European investors are on the front foot

The continued volatility in European markets is providing opportunities for those with expertise, says Apollo Global Management’s Ben Eppley.

This article is sponsored by Apollo Global Management.

Ben Eppley

The European debt market is functioning at a new level, despite interest rate rises and market volatility. Ben Eppley, the partner who leads performing real estate lending in Europe for US-headquartered manager Apollo Global Management, says the firm is filling a gap with traditional lenders by taking advantage of complex deals as the dust settles. Apollo, which had an almost $40 billion commercial real estate loan portfolio as of December 2022, mostly lends against properties in the US and across the UK and Western Europe.

Eppley spoke to Real Estate Capital Europe about how the company continues to have conviction in commercial real estate lending even after the recent interest rate shocks, and why the market is more fragmented than ever.

Many of the European markets Apollo operates in are currently experiencing high volatility. What are the main challenges for the business, and where are you finding opportunities?

We are navigating the same macro situation as everyone else, with inflation still strong, albeit seeming to taper, and various central banks increasing interest rates to try to combat it. That has resulted in an environment where real estate valuations are declining and real estate operating and financing costs are increasing. 

There is a lot of price discovery going on currently, with conversations among constituents in the market to try and find out where prices are going to settle. In turn, those levels will influence where lenders want to be positioning themselves, both in terms of new business and the existing book.

Because many of those conversations are happening in real time, the bid-ask spread between buyers and sellers and lenders and borrowers is still in flux, although we have seen it narrow as we have moved into the second quarter of the year.

The market and transaction environment is more muted than it has been in recent years, and that is true across geographies, although prime, stablised assets in the right property sectors still command low leverage liquidity for smaller to mid-size loans.

For Apollo, this means we are starting to see most of our activity and our pipeline built from refinancings or recapitalisations – essentially situations where borrowers have an event that they need to solve, such as maturity or liquidity issues, or covenant breaches. 

In those circumstances, a solution is necessary regardless of the wider environment. That could be additional equity coming into the capital structure, or another capital solution, such as a refinancing of a whole loan or a senior loan.

Has the current market environment changed Apollo’s focus?

Despite the wider market volatility in Europe, in some ways we are seeing a continuation of the opportunities we have enjoyed for many years. We have positioned ourselves as an alternative lender to fulfil capital requirements for borrowers that may not be transacting with the traditional senior lender universe or the bank market, and to take advantage of the banking market pulling back from certain segments. 

In Europe, for example, where the CMBS market is not as large as it is in the US, and there are more fragmented domestic banking markets, we have seen alternative lenders step into that space and provide the liquidity that the market needs.

The high inflationary and rising rates environment has simply accelerated existing trends that began with tighter regulatory and capital requirements. Specific lender risk appetites and legacy portfolios have also contributed to this evolution. 

Different lenders have different views on property types, jurisdictions, leverage points or business plans and are generally discerning, so the scope of what works for any individual lender may be narrow. As a result, we are trying to use this period as an opportunity to capture more market share, where we think the risk and returns are compelling.

There are still competitive segments: if a deal arises with a favoured property type, a great location and a great sponsor, there is a lot of liquidity vying for that. For anything outside of that, the liquidity dries up quickly, and the universe of lenders willing to look at certain types of loans – loans that we actually think may be defensive but are perhaps not as obvious – is limited, providing a lot of opportunities.

We are also finding deals where a sponsor has acquired an asset or site with a refurbishment or construction business plan but did not put the development debt in place at closing. Or the sponsor got caught in the unfortunate period where rates began to rise and now need to source third-party financing. We can solve that issue for them. 

Equally at the other end of the deal lifecycle, when projects are coming out of the redevelopment or capex phase and more time is required to lease a building or sell units, we can provide refinancing takeout loans to give sponsors more time to execute a business plan. 

We believe we have a competitive advantage due to the fact that we have permanent capital balance sheets that we are lending on behalf of. These are flexible in nature and are not origination for distribution; they are origination to hold. Therefore, we certainly feel we have a lot more room to run.

Are there particular asset classes that you favour?

As a lender, we tend to follow our sponsors and clients into their respective strategies. Every transaction we complete is a bottom-up underwriting and each deal stands on its own merits.  Once our clients present us with a new lending opportunity, we analyse where we find the most comfort and ability in underwriting transactions.

In general, we like the stronger sectors that have positive demographic and secular tailwinds behind them, such as logistics, residential and hospitality. But within each of those sectors, there are areas of focus where we believe we can add the most value.

For example, lending on a long-let logistics asset to an investment-grade corporate tenant that is stabilised and has strong inflation-linked cashflows will be a very tightly bid transaction and loan, and we probably are not the best source of capital for that. But if you have a development project or a portfolio that is a combination of standing assets that are cashflowing, standing assets that need to be let and development assets, then we see the opportunity in value creation and underwriting complexity. The deals where we like the underlying fundamentals – particularly where there are inventory loans, development financing or ramp-up plays – are the ones where we currently are finding the most compelling risk-adjusted returns.

Even with offices, where the statistics continue to trend in a negative direction, there are structural reasons why some assets will work. Great buildings, especially in specific markets and specific micro-locations, will continue to perform well because the tenant demand for the highest quality, sustainable office assets with strong amenities is likely to exceed supply.

Where do you view cap rates going in the next 12 months?

I think we are going to start seeing helpful transaction activity that will begin to give us an idea of the year ahead. Recent sales activity shows investors are spending considerably in an effort to pinpoint valuations. 

What we are doing is triangulating where public company valuations have gone and the few data points for private market sales, as well as looking at the different historical relationship between interest rates and cap rates and operating fundamentals and cashflow trends. That allows us to work out a reasonable range within which we think valuations will end up. Because we are a lender, by definition we have built in a margin of safety through the equity subordination.

We are already beginning to see true sales activity and recapitalisations that include money coming into deals at valuation levels, plus the benefit of the public market data points. As a lender, you can look at those various metrics and try to get comfortable with where you might land.

That said, I think there will be some continued volatility throughout the next year, and if the last few years have taught us anything it is that you cannot predict those one-off exogenous events that impact the market. Overall, I think the longer-term trend will be towards the calming down of the market and a settling down of the bid-ask between buyers and sellers.

What is the sentiment among your clients for the current market?

Generally, we are seeing a lot of caution, but that is driven by the latest macroeconomic or regulatory developments plus a host of other external factors. What is safe to say is that there is still a lot of capital interested in real estate and real estate credit in particular, along with different types of real estate equity strategies. 

One of the things that we have heard a lot from different clients and investors is the continued appetite for real estate debt. Declining valuations means you can lend at a lower basis; declining loan-to-values means you can lend at an even lower level than that; and widening base rates and widening credit spreads mean you can make higher yielding loans in a more defensive position. A key takeaway from the past 12 months is the strong belief in real estate as an asset class, and it is not going away.